Defensive Repurchases: The Managerial Entrenchment versus Shareholder Interests

1
Defensive RepurchasesThe Managerial
Entrenchmentversus Shareholder Interests
Sheng-Syan ChenChia-Wei Huang
2
Introduction

• Commonly cited motives for open-market repurchase
  include
• Distributed free cash flows
• Signaling undervaluation
• Funding employee share option plans
• Adjusted capital structure
• Strategic reaction to competing firms repurchase
  decisions
• Defense against unwanted takeovers.

3
Introduction (conti.)

• The majority of research in open-market
  repurchase has focused on the motives of
  distributing free cash flow and signaling
  undervaluation.
• In the most recent years the study of open-market
  repurchase has apparently moved from the motive
  for signaling undervaluation attitudes to more
  motive for the nonsignaling stances (Billett and
  Xue (2007) and Massa, Rehman, and Vermaelen
  (2007)).

4
Introduction (conti.)

• Why the open-market repurchases does a potential
  tool for defending against unwanted takeovers
• Open-market repurchase may increase the
  acquisition price and the cost of acquisition
  (Bagwell (1991), Brown and Ryngaert (1992), and
  Hodrick (1999)).

5
Introduction (conti.)

• Open-market repurchase may alleviate agency
  concerns and their associated costs, reducing
  potential gains from disciplinary takeovers
  (Hirshleifer and Thakor (1992)).
• Open-market repurchase firm can quickly respond
  to unwanted takeovers since the open-market
  repurchase program has a flexibility to allow
  repurchase at any time.

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Introduction (conti.)

• What management incentive does the firm goes to
  defensive repurchase ?
• So far, no studies have directly examined the
  relation between the firms defensive open-market
  repurchase and management incentives.

7
Hypotheses Development

• The target firms management may lose his
  employment, position or power in the firm.
• Kini, Krackaw, and Mian (1995) found an inverse
  relationship between post-takeover management
  turnover and pre-takeover firms performance.
• Mikkelson and Parch (1997) also found that the
  turnover rate for companies with poor performance
  prior to takeover in more active takeover market
  is larger than in less active takeover market.

8
Hypotheses Development (conti.)

• Thus, management has incentive to use active and
  preventative corporate defenses to deter unwanted
  takeover attempts.
• Previous studies found that most takeover
  defensives resulted in a sharply decreasing in
  shareholder wealth (Comment and Schwert (1995),
  Masulis, Wang, and Xie (2007), and Bebchuk,
  Cohen, and Ferrell (2009)).

9
Hypotheses Development (conti.)

• H1a(The managerial entrenchment hypothesis)
• Managers who conduct defensive open-market
  repurchase may be motivated by an attempt to
  entrench itself at expense of firms constituent
  shareholders. Repurchasing firms with higher
  takeover probability are more likely experiencing
  a worse performance than those firms with lower
  takeover probability.

10
Hypotheses Development (conti.)

• The adoption of open market repurchases should be
  accompanied by stock price increases, because the
  repurchasing is adopted primarily to protect
  shareholders from receiving less than full value
  for their holdings in control transactions.
• Several studies provided evidence that takeover
  defenses have a positive impact on shareholder
  returns (Comment and Schwert (1995) Coates
  (2001), Stout (2002) Bhaghat and Jefferis
  (1991), Mcwilliams (1990), and Boyle, Carer, and
  Stover (1998)).

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Hypotheses Development (conti.)

• H1b (The shareholder interests hypothesis)
• Managers who conduct defensive open- market
  repurchase may be motivated by an attempt to
  maximum shareholders value. This hypothesis
  predicts that repurchasing firms experience
  superior performance.

12
Hypotheses Development (conti.)

• Shleifer and Vishny (1986) indicates that
  concentrated ownership creates the incentives for
  large shareholders to monitor the firms
  management, which mitigates the free-rider
  problem. Accordingly, a firm with strong
  monitoring by shareholders would reduce the
  agency costs.
• Therefore, a management of repurchasing firm is
  more likely to entrench itself when he is
  employed in a bad-governed firm.

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Hypotheses Development (conti.)

• H2 Repurchasing firms with higher takeover
  probability are more likely experiencing a worse
  performance than those firms with lower takeover
  probability, and this should be more significant
  in the firms with poor governance mechanisms than
  those firms with better governance mechanisms.

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Hypotheses Development (conti.)

• Open-market repurchase program is not necessary
  to commit the firm to actually repurchase shares
  since insufficient disclosure in the U.S.
  companies.
• If the firm refrains from buying shares within
  the subsequence month of open-market repurchase
  announcement, it is less likely that manager
  defenses unwanted takeover bids.

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Hypotheses Development (conti.)

• H3 The change of repurchasing firms
  stock/operating performance is more significant
  on the post-announcement drift than initial
  market reaction for management incentives to
  either entrenched his position or maximized the
  shareholders wealth.

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Sample Selection

• Sample for estimating The ex ante Takeover
  Probability.
• The entire common stock (with the Center for
  Research in Security Prices (CRSP) share code
  equal to 10 or 11) that trade on the NYSE, Amex,
  and NASDAQ, and research data available from
  COMPUSTAT and CRSP.
• The sample period extends from 1990 to 2003.
• Following Billett and Xue (2007), we exclude
  firms operating in financial and utilities
  industry, and firms with a share price below five
  dollars.
• The final sample has 24,788 observations for
  estimating the variable TOPROB.

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Sample Selection (conti.)

• Sample for open-market share repurchases
• The open-market repurchases sample is collected
  from the Securities Data Companys (SDC) U.S.
  Mergers and Acquisitions database between 1990
  and 2003.
• The resulting sample contains 3,270 firms.
• The estimated Actual Repurchases
• We compute the estimate of the dollar amount of
  common stock repurchased during the quarter of
  and the quarter after the open-market repurchase
  announcements as purchase of stock minus the
  decrease in preferred stock or redeemable
  preferred stock (Hribar, Jenkins, and Johnson
  (2006)).

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Sample Selection (conti.)

• The estimated Actual Repurchases
• The actual share repurchases (REP) is measured as
  the estimate of the dollar amount of share
  repurchased divided by the market value of common
  equity.

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Empirical Methodologies

• Takeover Probability Estimation
• Following Billett and Xue (2007), we measure the
  ex ante takeover probability (TOPROB) by
  estimating a probit model.
• The explanatory variables are winsorized,
  exception of the dummy variables and SIZEEQ, at
  the 1 and 99 percentiles.

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Empirical Methodologies (conti.)

• Stock Performance
• The short-run CARs is measured by the open-market
  repurchase firms 5-day (-2,2) CARs relate to
  the announcement date minus its corresponding
  size- and MB-portfolio returns.
• The long-run buy-and-hold abnormal returns are
  compound by monthly returns for one-year
  (two-year) window defined as 12 (24) months (or
  up to the repurchasing firms delisting month)
  after the open-market repurchase announcement
  date and adjusted its corresponding size- and
  MB-portfolio returns.

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Empirical Methodologies (conti.)

• Stock Performance
• We do both robustness checks using the
  Fama-French (1993) three-factor model.

22
Empirical Methodologies (conti.)

• Operating Performance
• Following Lie (2005), the operating performance
  is measured as the performance-adjusted
  return-on-assets (ROA) after the open-market
  repurchase announcement quarter.
• The performance-adjusted ROA is the repurchasing
  firms ROA minus the ROA of a matched firm with
  similar pre-event performance and/or the same
  industry and/or similar market-to-book ratio.

23
Empirical Methodologies (conti.)

• Corporate Governance
• The institutional blockholder is measured as the
  sum of all ownership positions greater than 5
  held by institutional shareholders. (the
  CDA/Spectrum institutional holdings (13-F
  filings) database).
• We define the Good (Bad) Governance for firms
  located in the highest (lowest) tercile of
  institutional blockholder ownership.

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Empirical Results
25
Descriptive Statistics-Table I
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Descriptive Statistics (conti.) -Table I
27
The ex ante Takeover Probability Estimation-Table
II
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The ex ante Takeover Probability Estimation
(conti.)

• The mean (median) of the estimated takeover
  probability (TOPROB) is 5.81 (5.59) and the
  range is from 0.31 to 27.52.
• The 5th and 95th percentiles are 1.43 to 11.22,
  respectively.
• Overall, our estimation results are quite similar
  to Billett and Xue (2007).

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The Determinants of Actual Share
Repurchases-Table III
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Takeover Probability and Stock Performance-Table
IV
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Takeover Probability and Stock Performance
(conti.) -Table IV
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Calendar-time Approaches-Table V
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Calendar-time Approaches (conti.) -Table V
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Regression Analysis

• We capture the entrenchment aspect of the
  open-market repurchase activity through an
  interaction term denoted by TOPROBREP.
• The TOPROBREP measures the effect on the stock
  abnormal return resulting from a share repurchase
  that is conditional on higher takeover
  probability.

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Regression Analysis (conti.) -Table VI
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Regression Analysis by the strength of
Governance-Table VII
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Takeover Probability and Operating
Performance-Table VIII
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Takeover Probability and Operating Performance
(conti.) -Table VIII
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Robustness Analyses
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Controlling for Earnings Management and Market
Competition

• Raman, Shivakumar, and Tamayo (2008) find that
  takeover decisions are influenced by the quality
  of information in target firms earnings.
• We measure earnings management as abnormal
  accruals that calculate the residual from the
  modified version of the Jones (1991) model (Louis
  and White (2007), Gong et al. (2008), and Louis,
  Robinson, and Sbaraglia (2008)).

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Controlling for Earnings Management and Market
Competition (conti.)
Abnormal Accruals
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Controlling for Earnings Management and Market
Competition (conti.)

• The market competition acts as a disciplinary
  mechanism on managerial behavior (Leibenstein
  (1966), Hart (1983), Schmidt (1997), and Shleifer
  and Vishny (1997)). Managers of firms operating
  in more concentrated industries are more likely
  to put corporate sources into inefficient uses
  for the self-interest motive.
• The top (bottom) quintile of the Herfindahl index
  is represented unique (competitive) industry.

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Controlling for Earnings Management and Market
Competition (conti.) - Table IX
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Controlling for Earnings Management and Market
Competition (conti.) - Table X
45
Controlling for Earnings Management and Market
Competition (conti.) - Table X
46
Sensitivity Test (Dummy Approach) - Table XI
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Conclusions

• Both univariate and multivariate results support
  the managerial entrenchment hypothesis.
• Even we control for the effect of earnings
  management and market competition, we still
  support the managerial entrenchment hypothesis.

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Conclusions (conti.)

• Our results contribute to the literature on
  open-market repurchases by documenting
  open-market repurchase as a tool for management
  entrenching his position.
• Our results contribute to the literature on
  post-repurchase abnormal returns and operating
  performance by providing a new way to explain the
  post-repurchase drifts.